Human face of risk

Starting discussion about risk management usually causes hate reflex or at least reluctance in inquired audience. We fill in risk assessment logs, discuss long lists of red lights created in excel. We assess risk impact and probability.

We spend days and nights arguing with each other that the risk item is – or actually is not – the REAL risk for us and our work.

But we tend to forget why we even started to talk about risk at all.

Because of us.

We, as human beings, show natural tendencies towards risk and these tendencies can explain, why some of us would create risk logs for a whole day, whilst the others comment it with rolling eyes.

Here I will focus on three focus points, when talking about human aspects of risk management: general risk preference, stakeholders’ risk appetites and decision rules.

Risk preference

People fall into one of three categories of a risk preference. Even if we observe some shades, we are either risk averse, risk neutral or risk seeker.

Risk averse person will try to avoid hazard in actions taken, usually at the cost of the higher return. Actually return is second priority, safety is the most important. People who are risk averse will always assume the worst case scenario to happen.

Risk seeker decision maker will reverse the priorities: return on investment has to be maximized no matter what risk is associated with this situation. Additionally this kind of person will try to secure the best outcome even if the chances for it are very small.

Somewhere between the two extremes are risk neutral people. They will look for the most likely outcome, trying to maximize the return but with reasonable level of risk associated with the return.

It’s worth to be aware of this classification of people’s risk types, not only when discussing project risks, but also when trying to persuade someone to the new idea or when building business case. Whilst no one is probably really thinking about personal risk preference, it is something that applies to most of us all the time.

Stakeholders’ risk appetite

Switching the perspective from personal to company leads to the concept of risk appetite. This is the way how we call the amount of risk an organization is willing and ready to accept in order to pursue the strategic objectives.

Company’s risk appetite may be perceived as combined perspective of different groups of stakeholders with various level of risk acceptance (e.g. employees may be rather risk averse, whilst shareholders may look for more aggressive increase in their wealth). But the other perspective is risk appetite of the company as a whole. This should be carefully defined and articulated constantly to all interested parties to ensure clarity over the acceptable level of risk.

The company itself should also take preventive actions before the stakeholders’ risk appetites are being breached what can be addressed by application of risk impact/probability matrix.

Decision rules

Business decisions should be based on both downsides (negative impact of a risk related to losses) and upsides (gains) of a given course of action. But, because of a human nature of risk, the same numerical results can be treated differently by various stakeholders depending on their risk preference and appetite. Individuals risk attitude can determine their decision-making criteria.

Decision rules formulated within decision theory framework are one of the ways of dealing with conflict or uncertainty. They base on payoff tables built for different risk scenarios.

There are three criteria of decisions making: maximin, maximax and minimax regret.

Maximin decision maker will look for maximizing the minimum achievable profit (the best of the worst). This is pessimistic or conservative approach taken under conditions of uncertainty. Person, who is taking decision based on maximin criterium, always assumes that the worst scenario will happen and out of all of the worst scenarios chooses the biggest payoff.

Maximax decision maker will try to maximize the maximum achievable profit (the best of the best). It is optimistic (also called aggressive) approach that assumes always the best will happen to us. It tends to ignore probability and leads to over-optimistic decisions, on the other hand maximizing the profit in favorable circumstances.

The third one is minimax (opportunist) regret rule. It will look for minimizing the regret from taking wrong decision (the worst of the best). Regret in that sense is the opportunity lost due to making wrong decision. Minimax uses the same method of approaching the risk as maximin – it looks from the loss perspective (whilst maximax looks from the gain perspective). And out of the best scenarios tries to find the option where the regret will be at the lowest possible level.

Decision rules, combined with  awareness of risk appetite and risk preference may help to understand not only people’s behavior and reactions to certain proposals, but also help to build understanding and enhance communication and dialogues within a group. Hence, keeping that in mind when formulating risk management strategy or adding risk review to our feedback loops, may serve in achieving better and quicker results with sustaining high level of respect towards each others opinions and goals.

*************************

Writing this article I used:
http://www.businessdictionary.com/definition/decision-theory.html
“Advanced Performance Management. Study Text”, BPP Learning Media Ltd., 2015
Picture by Pixabay.